The U.S. Environmental Protection Agency (EPA) is increasingly looking to regulate coal use, with the U.S. court system ending up as the main battlefield. The EPA just scored a big win, but that doesn't mean the fog of war has lifted.
As the wind blows
In 2011, the EPA put forth rules to deal with pollution created in one state but that gets blown into another. The idea was to make "up wind" states pay their full share for the pollution they cause. Needless to say that set off a legal battle with "up wind" states on one side and the EPA and "downwind" states on the other.
The Supreme Court essentially gave the EPA mandate, known as the Cross State Air Pollution Rule, the green light. But what does that actually mean for the coal and utility industries?
There are still two big issues. The first is quantifying the environmental impact that "upwind" states have since there are multiple up- and down-wind players. Then there's calculating how much this will cost each state financially, since that aspect of the rule was left purposely vague.
The Supreme Court decision came out just in time for Cloud Peak Energy (NYSE:CLD) CEO Colin Marshall to field a question about it: "Our first reaction to that was well we will have to see how it plays out." He highlighted uncertainty over when the rule will be implemented and the impact of other regulations that are in the pipeline.
That said, Cloud Peak's Marshall noted, "it's probably too early to tell but overall... I'm comfortable with our overall view that the PRB demand will be relatively stable." Stable domestic PRB demand would be good news for Cloud Peak since that's the only region in which it operates.
The company posted a first quarter loss of around $0.25 a share partly because of weather-related delivery problems. That's the first quarterly loss for the miner during a period that can only be described as difficult at best. However, Cloud Peak has contracted all of its coal this year, and the second half of the year is likely to look a lot better than the first half -- especially since PRB coal prices appear to be recovering, a fact that should have an even greater impact on 2015 results.
Some hurt in the future
The longer term impact on coal miners like Cloud Peak, however, will come from utilities like AEP (NYSE:AEP). This company has major operations in "up wind" states like Ohio and Texas. Texas Solicitor General Jonathan Mitchell, for one, complained to the court that the "EPA has left the states completely in the dark about the meaning of the phrase 'contribute significantly.'"
And that's what, in the end, will determine weather or not AEP upgrades or shuts down more coal plants. Coal made up 75% of AEP's footprint in 2013, so it's a big issue to address. To be fair, AEP has been spending to reduce its emissions, with reductions in sulfur dioxide of 70%, nitrogen oxides of 64%, and CO2 of 21% since 2005.
AEP has already been culling its coal fleet, where capacity is set to fall about 30% from 2005 levels. If EPA rules make the cost of operating coal plants go up further, it wouldn't be surprising to see AEP shut more down. That would make Cloud Peak's early expectations overly positive. It would also make more of the country reliant on frequently volatile natural gas, which has picked up the mantle at AEP -- its use has grown 65% since 2005.
The fight is not over
It's likely that this fight isn't over, since there's going to be plenty of push-back against any financial impact imposed by the rule. That said, this is an important situation to monitor for coal miners like Cloud Peak and for "up wind" utilities like AEP. Make sure to keep your eyes on this still moving ball.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.